If you’re looking for a life insurance policy that will grow your wealth while you’re alive and still provide financial security for your loved ones after you’re gone, then you should take a look at universal life insurance vs whole life insurance.
But which one is right for your financial goals? In this article, we’ll break down the differences between standard universal life insurance and whole life insurance, plus explain the differences between each additional type of universal life insurance: guaranteed, variable, and indexed.
Before we get into the comparison between the two, it’s important to go over some basic life insurance terminology first so we can better understand some of the nuances between the two.
Key Takeaways:
- When considering life insurance policies that provide financial security for loved ones and the potential to grow wealth during the policyholder’s lifetime, it’s essential to compare universal life insurance vs. whole life insurance.
- Universal life insurance more affordable than whole life insurance but comes with increased risk.
- Both policies have a cash value component that can be used like as a savings account, but the interest and growth potential vary.
- Universal life insurance premiums are flexible, while whole life insurance premiums are fixed.
- Policyholders can take out loans and withdrawals from both policies, but there are potential consequences to consider.
- Universal life insurance has different types, including non-guaranteed, guaranteed, indexed, and variable, each with unique features and benefits.
Life Insurance Terminology
Insurance Cost
The cost of universal life insurance and whole life insurance are both determined by age, gender, and health status. Lifestyle has a big impact, including factors such as tobacco and alcohol use, hobbies, work-related risks, and travel.
Whole life insurance and universal life insurance have similar underwriting standards, but universal life insurance is generally less expensive. However, the reduced cost of universal life insurance comes with increased risk. Whole life insurance offers benefits that are not found in universal life policies. These benefits include guaranteed premiums, guaranteed death benefits, and guaranteed rates of return.
With both life insurance policies, a portion of your premium goes towards the death benefit, which is the face value of the policy. In the first few years of your policy, there are also administrative costs that are charged. The rest of the cost goes into your cash value.
Typically costs will depend on the above factors, but also largely depend on how much life insurance you are looking for. Generally speaking you could purchase upwards of 25 times your annual income in either of these policies.
Cash Value of Life Insurance
Both kinds of life insurance policies have a cash value component that acts like a savings account, accruing interest over time.
The interest you earn with a universal life insurance policy varies depending on the market or minimum interest rate, whichever is greater. The amount of interest you earn varies between different types of universal life insurance. Universal life insurance policies may see larger growth in years when the market is performing well. However, the growth is less predictable and policy premiums may rise to a point where they cancel out any gains, or even exceed them. If an insurer experiences subpar returns in the market, they will often increase policy premiums to make up the difference. This can mean that policyholders will get less money back, and they will have to pay more for their premiums.
Whole life insurance policies net a guaranteed rate of return, indifferent of market changes, and may also earn dividends when set up through mutual insurance companies. With a whole life policy, the cash value will not go down if the market crashes and the premiums will stay the same for as long as the person is insured. When you have whole life insurance, you can depend on the cash value it accrues. This can be helpful if you plan to retire or need business capital, as the cash value will be there for you.
Infinite Banking Cash Value
One nuance to this discussion is that life insurance policies that are designed specifically for use of their cash value have become popularly known as “Infinite Banking” or “Bank on Yourself” policies.
The idea with these is that you can borrow out the cash value you have accumulated in your policy at fairly low interest rates. A repayment schedule is totally up to you as long as you keep up with the interest payments.
We use these as a core component of our financial freedom plan and keep all of our business and personal reserves in a cash value account.
Policy Premium Payment
Most universal life insurance policies have flexible premiums. The pay range for premiums falls between a minimum and maximum amount, which the policyholder can choose from depending on how much they wish to pay. This is because universal life offers more flexibility than other types of life insurance policies. Most whole life insurance policies have fixed premiums.
Whole life insurance premiums stay the same over the course of your life, while universal life insurance premiums usually go up as you age. Your insurance company can also choose to raise universal life premiums whenever they want. If your goal is to have enough cash value in your universal policy to cover your increasing premiums, you may run into trouble if you can’t pay or if your cash value is already depleted. In either of these cases, your insurance will no longer be active. The value of your policy could eventually decrease to the point where it’s worth nothing, meaning you would no longer receive benefits while alive, and your family would not receive a death benefit.
If you take out whole life insurance, your premiums will stay the same throughout your life. If you get insured at a younger age, your premiums will be lower. => You can secure a low insurance rate from a good insurer and keep that rate for life. In a similar way to universal life, the cash value you have built up can be used to pay your premiums. If you stop paying premiums, your insurance will lapse and you will no longer be insured. If you cannot pay your insurance premiums, your policy will expire and you and your family will no longer be able to receive insurance benefits.
Whole life insurance has some flexibility in how you can pay the premiums, including changing your payment schedule and using dividends. You can also reduce payment on some riders, like a Paid-Up Additions rider, and reduce coverage as a last resort.
In particular with our infinite banking policies, we have a “range” of payments that we can make. We always need to pay the premium payment and this sets the low end of the yearly payment. Additionally we can “store” extra cash value in the form of paid up additions.
Policy Loans From Insurance
You can take out a loan from your universal or whole life insurance policy without having to pay taxes on it, as long as the amount you borrow is equal to or less than the cash value of your policy. If there are any loans on the policy, the amount of the death benefit paid to beneficiaries will be reduced by that amount, plus any interest that is owed.
There is no pre-approval or credit score requirement to use the policy loan feature of your insurance. Funds are typically available a few days after you make a claim and are deposited into a bank account that is connected to your insurance policy. And you determine the payback schedule for your loan.
A policy loan is a loan that you can use for any purpose. Some examples of how you could use a policy loan include paying policy premiums, covering tuition costs for your children, purchasing real estate, capitalizing on investment opportunities, operating a business, and funding retirement. Your insurance policy can provide you with cash in an emergency situation.
You still earn interest or market gains on the full cash value of your policy, regardless of the amount you have borrowed against it. Cash value can serve two functions at the same time: it can be borrowed and earn interest.
Use of these policies in this way makes a fantastic way use as a base for all of your investible capital. Only taking out policy loans when you have an investment in mind.
Withdrawals From Your Insurance Policy
You are able to withdraw the cash value from your insurance policy as you please. Both whole life insurance and universal life insurance policies allow you to withdraw the money that you have put into them, but there are a few things that you should consider before you do this.
If the amount of money you receive from your life insurance policy is more than the amount you’ve paid in premiums, the difference is considered taxable income.
If you take out the cash value from your policy, it may reduce the coverage amount (the face value), which could leave your loved ones with less money after you die.
If you want to access the cash value of your life insurance policy without having to repay it, you would consider making a withdrawal. It allows you to access your cash value without having to surrender your policy.
Whole Life vs. Universal Life Insurance
If you want to be permanently insured, you may have difficulty choosing between whole life and universal life insurance. Your preference between whole life and universal life insurance depends on your financial goals and income.
- Generally speaking, universal life might be a better option if you’re interested in whole life, but also:
- Have financial goals you wish to meet using permanent life insurance.
- Are more savvy and comfortable with investments.
- Have a high income and can pay larger premiums upfront to build cash value (or cover a higher cost of insurance when you’re older).
- Are more interested in using life insurance for estate planning.
What Is Universal Life Insurance?
Though universal life insurance is similar to whole life, it is more flexible and can be adapted to changes in your needs and financial situation. -Whole life insurance pays a fixed rate of interest, while universal life insurance offers a variable rate of interest that is based on market conditions. -Whole life insurance has a set premium, while universal life insurance offers the policyholder the flexibility to choose their own premium. – Universal life insurance offers the policyholder the ability to choose how their death benefit is paid out, while whole life insurance offers a set death benefit payout. Universal life insurance is a type of permanent life insurance that offers policyholders the ability to choose their own premium, how their death benefit is paid out, and a variable rate of interest that is based on market conditions.
Flexible Premiums
The ability to pay more, less, or even skip payments altogether, depending on your current financial situation, is one of the advantages of having a Universal life insurance policy. The amount of flexibility you have may depend on the amount of cash you have, the current interest rate, and whether or not you have any loans or withdrawals. Your premiums can go up to a certain point set by the IRS, or down to a set minimum limit.
Adjustable Death Benefit
A traditional whole life policy pays out a death benefit that remains the same unless there is an outstanding loan balance when the policy is paid out. The amount of benefits you receive can be increased or decreased within certain limits, but if you want to make a significant change, you may have to go through a medical underwriting process. Also, there may be fees for decreases.
Level or Increasing Death Benefit
With a universal life insurance policy, you have the option to add a rider or include the cash value as part of the death benefit. Raising your premiums will result in a larger death benefit for your beneficiary. This means that if you have a life insurance policy worth $300,000 with a cash value of $50,000, your beneficiary will receive a total of $350,000 when you die.
Secondary, or No-Lapse, Guarantee
Some insurance policies have coverage for this built in, while others offer it for an additional fee. A UL policy may lapse for various reasons, such as an increase in administrative expenses, insufficient premiums to keep the policy from lapsing, or interest rates falling below expectations. This option ensures that your policy will be valid for a certain amount of time, regardless of any changes in circumstances. You may lose this benefit and your protection if you take out a loan, partially surrender, or don’t pay premiums.
How Does Universal Life Work?
Universal life insurance offers flexibility with lifelong protection. However, learning about the different components and costs associated with this life insurance product is crucial to understanding if it’s right for you:
The premium is the amount of money you pay into your life insurance policy. After you initially pay your premium for a universal life policy, many companies have a minimum premium that you must pay to cover expenses, taxes, and the policy’s cost. The insurance company’s portfolio earning more than the guaranteed interest rate is credited to your policy value.
This is the amount that is charged for the costs of insurance mortality, fees, commissions, and any overhead that is deducted from your premium payments. The balance goes toward the policy cash value.
The deductions for insurance costs are taken out of the policy value each month. The benefits covered by life insurance policies include the death benefit, any riders purchased, and supplemental benefits.
The administrative expenses for a policy are deducted monthly from the policy value to cover the costs of maintaining the policy. Administrative fees are usually charged for services such as accounting and record keeping.
If you end your policy or take out a loan during the surrender charge period, your policy will be reduced by this amount. Specific details regarding length and amount vary by plan.
Types of Universal Life Insurance
There are four main types of universal life insurance: non-guaranteed, guaranteed, indexed, and variable. The type of coverage that is best for you will depend on your financial goals and needs.
1. Traditional or Non-Guaranteed Universal Life
The most affordable type of universal life is the traditional or non-guaranteed universal life policy. If you make changes to your policy, there is no guarantee that it will not lapse. If you are looking to save money on your insurance premiums, traditional universal life insurance may be a good option for you. You will still need to make sure that any changes you make will not cause the policy to expire because you have not paid enough in premiums to keep the policy active.
2. No Lapse Guaranteed Universal Life
A no-lapse guaranteed universal life policy provides all the benefits of traditional universal life insurance with the added guarantee that the policy will not lapse. You must pay a minimum premium based on your coverage amount to ensure that your policy will not lapse. If you do not want to have to closely monitor your policy, but still want the features of a universal life insurance policy, this may be a better option for you.
3. Indexed Universal Life
An indexed universal life policy places cash in a market index fund to grow your cash value faster. This is different from traditional universal life insurance, which typically has a modest interest rate and slowly accumulates cash value. 0-1% is the minimum guaranteed return on investment for an index universal life policy, though this number varies depending on the insurance company. Only use this fund if you understand the stock market or are working with a financial advisor you trust, as the policy could lapse if it doesn’t reach target premiums or if its value isn’t high enough to cover costs and fees.
A typical index that your policy can get tied into is the S&P 500.
Many times these kinds of policies have booth a “floor” or minimum and a “ceiling” amount that your cash value can grow or decline. Typically the minimum is 0% and ceiling is 12%. While this provides safety for your cash value against market crashes, it also limits the amount that your policy can grow it’s cash value.
4. Variable Universal Life
Variable universal life insurance is similar to index universal life insurance in that it can speed up cash value growth through investments. Variable Universal Life policies offer more flexibility than other types of life insurance policies. With a Variable Universal Life policy, the cash value can be invested into indexes, money market accounts, or stocks. Investments can be mixed, allowing for faster growth, but there is usually a limit on how much you will receive. product. Only the most experienced investors should consider variable universal life insurance, as there is a greater chance of the policy being canceled than with other types of universal life insurance.
Final Thoughts on Universal Life Insurance vs Whole Life Insurance
From a consumer perspective, the framework we use to decide which kind of policy to get is to think about the goal of it. Our own personal take here at 40PlusFinance.com is that we prefer the guaranteed returns of a whole life policy vs the potential variability of a universal life policy.
From the perspective of working towards financial freedom, it’s important to use insurance as a place to store our liquid capital and still earn decent returns on it (between 3%-4%). Once your cash is secure and you have built up enough cash reserves for business and personal emergencies, then you can go out and start buying cash flowing assets like Turnkey Real Estate.
What about you, the reader? What kinds of insurance do you prefer? Let us know in the comments.
Kurt has gone from the financial lows of the ’08 financial crisis to personal financial success. He is a professional real estate investor owning properties in multiple states.
One of his passions is financial education and the pursuit of financial freedom.
You can learn more about Kurt here.
